A conundrum relating to full reserve banking.

One of the basic flaws in the existing bank system is that commercial banks (i.e. money lenders) can to a significant extent simply print the money they lend out: i.e. create it via book-keeping entries out of thin air. If you’re a money lender, clearly that’s preferable to having to actually EARN the money you lend out or borrow it at the going rate of interest.

That constitutes a subsidy of commercial banks: indeed the French Nobel laureate economist, Maurice Allais, and David Hume (writing almost 300 years ago) argued that the above activity essentially amounts to counterfeiting. Re Allais, see opening sentences here.

On the other hand it could be argued that no matter how dodgy a bank is, there is nothing wrong with government run deposit insurance which pays for itself, as does the US deposit insurance system, the FDIC. After all: if an activity pays for itself, if it’s commercially viable, what’s wrong with it?

And when the liabilities of a commercial bank (i.e. deposits at a bank) are backed by state run deposit insurance, those deposits are then “as good as gold”: i.e. they are as good as $100 bills or £10 notes.

So what’s wrong with that “commercially viable” deposit insurance? Well I suggest what’s wrong is as follows.

There is no sharp dividing line between money and non-money. For example, what’s the difference between $X of bonds which  someone holds in a reputable non-bank corporation and which mature in a week’s time, and $X which they have in a term account at a bank and which matures in a week’s time? Almost do difference at all!

Thus there are an infinite number of shades of grey between money and non-money, with the purest form of money being anything which is absolutely guaranteed not to lose value (inflation apart) and which is available to the “money holder” relatively quickly.

Thus the simple fact of upgrading a form of money from relatively dodgy money to “fully backed by taxpayers” money, which is what deposit insurance does, is itself a form of money creation. And whoever creates money is subsidised by the community at large, whether it’s a traditional backstreet counterfeiter turning out fake $100 bills or a respectable commercial bank creating money from thin air.

Ergo, deposit insurance is not quite what it seems: it is not a bog standard commercial activity which is entirely justified because it pays for itself. Part of the reason it pays for itself is that it is a surreptitious form of counterfeiting, or to put it in more polite language, it involves upgrading a not entirely secure form of money to something better. And that ipso fact is a form of money creation.